Iron Capital Insights

Last fall we had a market sell-off because the groupthink on Wall Street says that we are due for a recession. There was absolutely no sign of a recession in the U.S., but that didn’t matter. The data for the fourth quarter came in and not only are we not in a recession, but the U.S. economy grew at the fastest pace in more than a decade. Did they learn?

The market rally that greeted us in the New Year has hit a speed bump. Now we are down one week and up the next. So is the rally over and another downturn around the corner, or is the rally just getting started? In other words, which way do we go from here?

Federal Reserve (Fed) Chairman Jerome Powell has a communication problem. It must be incredibly frustrating because the problem really isn’t with anything he says; the problem is that the people he is talking to – market participants mostly – don’t actually listen.

We are still in a market downturn even after Santa tried to come to town on the second day of Christmas. We are even hovering right at bear market territory. This is happening in spite of record low unemployment and real wage growth. All signs are that the real economy within the U.S. is actually doing very well. So, what has the market so upset?

We were hoping for Santa Claus and thus far all we have gotten is Scrooge. The market is simply in a foul mood and nothing seems to be shaking it. Yesterday we got what we were all wanting and expecting when the Federal Reserve (Fed) raised rates a quarter of a percentage point and then…

As most of our readers know, I coach youth sports. Right now I am coaching my 8-year-old daughter’s soccer team. Two of the fundamentals of soccer are learning how to pass the ball and how to properly kick the ball. We want to control the ball so we teach them to pass with their instep and to kick with the top of their foot. The natural instinct is to kick with the toe. For young players just learning the ball will actually go farther with the toe, but toes are pointy, so the ball seldom goes where you want.

Just last night during a passing drill one of our best players kicked the ball with her toe instead of passing it properly. It went a long way…in the wrong direction. I asked her what caused that, and she admitted to kicking with the toe instead of passing. She knows what to do, but her desire to see the ball go far makes her not do it. In other words, she is currently refusing to learn. She’ll come around – they all do in their time – but children are not the only ones who refuse to learn.

Last fall we had a market sell-off because the groupthink on Wall Street says that we are due for a recession. There was absolutely no sign of a recession in the U.S., but that didn’t matter. The data for the fourth quarter came in and not only are we not in a recession, but the U.S. economy grew at the fastest pace in more than a decade. Did they learn?

Of course not. First quarter was going to be the beginning of slow growth. The initial estimate for GDP as calculated in the Wall Street Journal survey was 1.4 percent growth. Still growth, but less than half of what we averaged in 2018. The actual number came in at 3.2 percent. Did they learn?

Of course not. Now they say that growth in 2019 was just moved forward to the first quarter. Never mind that for more than twenty years the first-quarter number has almost always been the lowest of the year. We must have slower growth. Why? Good question, but they don’t really have an answer.

In the interim, the market has flown higher as we have erased last year’s sell-off and then some. The pundits keep trying to talk the market down. There is a saying in Wall Street that the market climbs a wall of worry. Most bull markets are marked by experts claiming doom around the corner. Every time someone tells me about some genius who predicted this or that market crash I respond thusly: Yes, and how many crashes that didn’t happen did he predict?

This, however, is different. There are a lot of pundits out there who seem to be trying to will us into a recession. One never knows what someone else is really thinking or their motivation, but it seems to me that many who pride themselves on their sophistication have allowed their personal feelings about our president to cloud their professional judgment regarding the economic impact of his policies.

This week it is once again the China trade negotiations. Trump sent out one of his tough Tweets about tariffs, “If the Chinese don’t finalize this deal by Friday….” For those paying attention, this is extremely familiar territory. This is almost exactly what happened in the trade negotiations with Mexico and Canada. Talks were good, then they slowed down, then Trump made threats and the deal got done.

Negotiation is often ugly, which is why people liked the idea of not negotiating for their next car. It is why these types of things used to be done in the “smoke-filled room.” Today we see it all, or almost all anyway. Much of it makes us nervous. I understand not liking the Trump methodology; I don’t care for it myself. However, not liking it is different from not recognizing it. We should have learned by now: this is how he negotiates. It worked with Canada. Will it work with China? I don’t know, but I think we have to give it the benefit of the doubt. Otherwise, we have to ask ourselves, are we learning?

Warm regards,

Chuck Osborne, CFA
Managing Director

~Refusing to Learn

The market rally that greeted us in the New Year has hit a speed bump. Now we are down one week and up the next. So is the rally over and another downturn around the corner, or is the rally just getting started? In other words, which way do we go from here?

This is always the question, isn’t it? There is an old saying: put 10 market analysts in a room and you will get 12 opinions. The data can be made to look any way one wishes at the moment, starting with GDP. The fourth quarter of 2018 came in with growth of 2.6 percent. That was higher than expected and gave us the roughly 3 percent annual growth for 2018 that the administration’s economic team promised. They say this proves that the “new normal” of 2 percent growth – which we were told by the previous administration was as good as it gets – was, in fact, not as good as we can do. We can bring America back to its historic growth rates.

The other guys (there are always other guys) say this is just a sugar high and economic growth will come crashing down now that we are back to reality. The market took the news of 2.6 percent growth positively, for what that is worth; until the unemployment report came out. The unemployment rate dropped to 3.8 percent, but according to the report, the economy created only 20,000 new jobs. That last number is not good at all. The naysayers had a field day with that. Look how bad the employment situation is, we are only creating 20,000 jobs that is horrible. The other side of that is that we have extended the longest period of sub-4 percent unemployment since the 1960s. Wages are also growing faster than inflation; more importantly, in my opinion: wages are growing faster at the lower rungs of the economic ladder. That means inequality is decreasing, but I wouldn’t hold my breath waiting to hear that from the naysaying crowd. The market reacted poorly to the unemployment report, for what that is worth.

Then we got some better-than-expected news from retailers. Do you see the pattern? Good news, not-so-good news, and news that could be taken either way. It is really in the eye of the beholder. So, where is the market going? To tell you the truth, I don’t have a clue. I hope that doesn’t bother you, but in case it does, let me explain.

First of all, none of these prognosticators has a clue; I’m just willing to admit that I don’t have a clue. Secondly, and more importantly, this is why we believe so strongly in investing from the bottom-up. I don’t need to know what retail sales numbers will be to know that Amazon is a winner, even if New York doesn’t want them. I don’t need to know the exact future of healthcare to know that United Healthcare is the best of the breed. You see, it is far easier to understand a company’s business and the potential for that business than it is to guess what will happen in the market next week.

Prudent investing is done from the bottom-up, and from what we can see there are still many attractive opportunities in the marketplace. Based on that knowledge I am optimistic about the future. Here is another thing I know: No matter where the market goes, it will not travel in a straight line. Every day or week the market is down, the financial media will find some pessimist predicting the end of the world as we know it. Every day or week the market is up, the same networks will find an optimist who will say that the market is headed for heights never seen.

In the meantime, real investors seek out opportunities one by one. Some may find it boring, but it works, and that is what matters to prudent investors. So let the pundits fight it out, we’ll just quietly do our job.

Warm regards,

Chuck Osborne, CFA
Managing Director

~Which Way Do We Go?

“Most people do not listen with the intent to understand; they listen with the intent to reply.” ~ Stephen Covey

Federal Reserve (Fed) Chairman Jerome Powell has a communication problem. It must be incredibly frustrating because the problem really isn’t with anything he says; the problem is that the people he is talking to – market participants mostly – don’t actually listen.

Don’t get me wrong, the market “hears” everything. In fact, the computer programming traders create programs specifically to look for certain words: If this word is in the statement then sell stocks, but if this word then buy stocks. Believe me, the computers hear it all. But, computers, at least for now, are not capable of listening.

Back in October Powell discussed the Fed’s plan to slowly raise interest rates to get them back up to a more historically normal range. The Fed’s outlook for the economy was very strong and they felt there would be plenty of room to raise rates. The market panicked.

What the market didn’t hear was that this plan was contingent on the Fed’s rosy outlook coming to fruition. When the Fed met a few months later, the market was down and signs of economic slowing were apparent in Asia and Europe. The economy in the U.S., with which the Fed is concerned, was doing great. Powell said the Fed still saw the economy doing well and that at this point they were still on target with their plan. Unfortunately, he used the word “autopilot.” That word is what the market heard. If they had been listening they would have known that they were on “autopilot” as long as the economic data stayed positive.

The story, however, was that the Fed was tone deaf, and everyone started beating them up while the market continued to sink. Then Powell spoke at a lunch in Atlanta. He emphasized that the Fed is dependent on the current economic data. All of a sudden, the market took off. The rebound was on and the story became the Fed has completely reversed course.

Last week the minutes of the last Fed meeting came out. Economic data is still good, but the rate of growth has slowed. The Fed spoke of altering their course if the data continues to show slowing growth. The market popped on the news. Now everyone is saying the Fed has become dovish and already people are beginning to question if it has become too dovish. The pundits start talking about this word being left out of the statement, or that word being added to the statement.

The truth is the Fed is continuing to do what it has always done. Parsing words may prove that one heard everything that was said, but it doesn’t mean he listened. If our economy is strong, the Fed will raise rates in the hopes of avoiding an overheating situation. If the economy is weak, the Fed will lower rates in an effort to stimulate growth. The effectiveness of their actions is, in my opinion, not questioned enough, but their actual message has not really changed since Paul Volcker retired in 1987.

If an investor wants to know what the Fed is going to do, then look at the data – that is what they do, after all. The good news for investors is that the market no longer sees the Fed as a risk in 2019; the bad news is that they never should have to begin with. The market would have known that if it stopped being the word police and started actually listening.

Warm regards,

Chuck Osborne, CFA

~We Hear, But Do Not Listen

The year was 1999, I was an analyst for INVESCO, and my boss asked me to go with him to meet with one of the firm’s most senior portfolio managers. Our mission was to teach an old dog new tricks. I was the 30-year-old analyst who instilled confidence in most audiences because I was smart enough to impress and young enough to be ignorant of all the things I didn’t know. We showed the gentleman lots of charts and data about how his investment process was out of touch with the market. He listened with more respect than we probably deserved and then he looked at my boss and said something I will never forget, “The market is wrong.”

My boss was respectful until we left the room. He then muttered some things I can’t print, but the point was, “Can you believe this old, out-of-touch so-and-so having the guts to say he is right and the market is wrong?” Shortly after that meeting, the senior portfolio manager was encouraged to retire. Four months later, the tech bubble burst. My boss was moved within the firm and I took his place. The senior portfolio manager formed a new firm and entered into a decade of incredible success. Turned out he was right and the market had indeed been wrong.

Fast forward 20 years and I feel a little like that old man. I’m not as impressive as I used to be because time has taught me to be more humble. I do know two things: The market can be wrong; in fact I believe it is wrong right now. I also know that John Maynard Keynes was correct when he famously said, “The market can stay irrational much longer than you can stay solvent.”

We are still in a market downturn even after Santa tried to come to town on the second day of Christmas. We are even hovering right at bear market territory. This is happening in spite of record low unemployment and real wage growth. All signs are that the real economy within the U.S. is actually doing very well. So, what has the market so upset?

Tariffs. Yesterday the Institute for Supply Management (ISM) Manufacturing Index came out and was weaker than expected. This index is a survey of manufacturers throughout the country who report on a host of business activity measures. The number itself wasn’t bad, although it was lower than the previous month, but when one reads some of the surveys there is a theme: Business is on hold until we figure out this tariff situation.

Here is the thing that seems to escape the Federal Reserve and some in the administration, and in fairness would have escaped me 20 years ago: Markets are based on moods and emotions. Most of the companies surveyed will likely see little if any real impact from the trade war, where thus far the barking has been worse than the biting. That doesn’t matter, because the threat that they might be impacted is enough to cause doubt. Doubt causes managers to put off business expansion.

Then one adds to that doubt with a bad report from Apple Inc., who sees revenues declining and blames it on a slowdown in China, at least in part due to trade tensions. Then Delta Airlines reports mostly good news, but has a slight miss on their revenue growth outlook. These are the types of reports that go practically unnoticed when the mood is high, but right now anything even slightly negative will drive the market down.

Reality is now very likely to be better than the market is forecasting. In other words, the market is wrong. This is an opportunity. Perhaps the best opportunity to buy stocks that we have seen in a decade.
I feel extremely confident that three years from now an investor who bravely buys while others are panicking will be hugely rewarded. The problem is what happens between here and there.

This is a long-term buying opportunity for patient investors, but three months from now may be an even better opportunity. In other words, to paraphrase Keynes, the market can stay wrong for longer than one can stay solvent.

Investing is about balance. Balancing risk and return. Today the market is offering up a lot of short-term risk in return for some attractive long-term gain. Finding the balance is what prudent investing is about, and that is exactly what we will strive to do.

Warm regards,

Chuck Osborne, CFA
Managing Director

~The Market Is Wrong?

We were hoping for Santa Claus and thus far all we have gotten is Scrooge. The market is simply in a foul mood and nothing seems to be shaking it.

Yesterday we got what we were all wanting and expecting when the Federal Reserve (Fed) raised rates a quarter of a percentage point and then lowered the forecast for future raises. Chairman Powell said several times in his remarks that the Fed would ultimately be driven by the data. If the economy actually slows, then they will alter course.

Mr. Market acted like a spoiled child who just got everything he wanted for Christmas but throws a fit anyway. Since this market downturn started in October there has been a litany of reasons given for it. The first was that our economy is growing so fast that interest rates must rise; the 10-year Treasury has gone from 3.2 percent to under 2.8 percent as of this morning. The second reason was the trade tensions with China; there is now a cease-fire, and negotiations are at least happening. The latest reason is global growth slowing; there is no doubt that this is actually occurring. Asia, in particular, is looking weak with Japan already reporting a negative quarter and China’s growth slowing.

The big question is, will this slowing global growth spill over to the U.S.? Of course we can’t really know, but here is something to consider: The U.S. economy remains consumer-driven. Consumer spending represents roughly 70 percent of our total economic activity. More consumers are working today than at any time in almost two generations. Wages are growing above the rate of inflation for the first time since the 1990s. The U.S. looks very capable of once again leading the world economically.

A glimpse into this was seen yesterday in Federal Express earnings. Federal Express’ revenue grew faster than expected overall. They saw good growth domestically, but painted a bleak picture for their European and Asian business. The market punished them. Lost in this knee-jerk reaction was the fact that the U.S. demand was strong enough for Fed Ex to beat on revenue even with its international business being down. I’m old enough to remember when the U.S. often led the world in this way.

The probability of the global economy being better than expected next year is high and growing, partially because the pessimism is exaggerated, and partially because they are not giving the U.S. consumers the respect he and she deserve. That bodes well for the future and may explain why emerging market stocks, which had been the worst place to be all year, have quietly begun to outperform.

It is always painful to see portfolio values drop. However, it is precisely in times like this that we must remind ourselves of our long-term (three- to five-year) goals and the prudent fundamentals that will help us achieve those goals. We invest from the bottom-up. There are many companies that remain strong and whose businesses are doing very well. Their stock has just gone on sale and in some cases represents great bargains. It is far easier to spot a bargain than it is to guess what the market as a whole will do.

We have to be risk-averse. Now is a time for looking for opportunities. To paraphrase Warren Buffett, a prudent investor is greedy when others are fearful and fearful when others are greedy. Our mindset should be one of seeking opportunity, but we also have to respect the market. It is not time to jump in with both feet, as no one really knows how long this selloff will continue.

So we are neither going to panic nor go hog wild. We are going to keep our heads about us while those around us lose theirs. If we do that consistently then the world just might be ours, as Mr. Kipling suggested all those years ago.

The market may be delivering a lump of coal, but Christmas morning will come nonetheless and all will be much cheerier in the real world.